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Five Rules For Trading A Dip

Paul Price offers guidance on how to take advantage of big down days.
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Markets have been seeing big swings in recent days, driven by light holiday trading, worrisome economic data and pandemic news.

“There is one thing you can reliably count on when almost 100% of shares are down big on macro news stories,” Paul Price wrote on Real Money recently. “In most cases the true values of those companies had not changed from the previous trading day.”

Given that, Price offered up five rules for trading in the aftermath of a sudden downturn:

1. If you have cash in reserve ... deploy it while stocks are knocked down.

When the market drops overall, traders are selling stocks because of something that’s gone wrong with the market, not with the companies or businesses behind it. This means that those stocks are often undervalued relative to the strength of the companies they represent. Grab some deals while you can, because they’ll probably be back.

2. Triage your portfolio. Consider taking gains on positions that are above, at, or even near your goal prices in order to buy what was unjustifiably savaged.

Trade for liquidity. If you have assets that are where you wanted them to be, then don’t hesitate to sell in order to swap those for assets that got knocked down.

3. Swapping modestly depressed shares for severely pummeled stocks is one of the best ways to recoup what was lost and much more.

Also, don’t forget to trade “sort of undervalued” for “deeply undervalued.” Your goal is to take advantage of the biggest gaps between where assets are and where they should be.

4. Think about selling puts on stocks you'd like to own cheaper while volatility is elevated and put premiums are unusually generous.

Options can be your friend. Not only can puts give you a good chance to make some money while rolling valued stocks into your portfolio, but the premiums are a good source of quick cash to buy more undervalued assets.

5. Don't be shy about extending put option maturities out to January 2023 or January 2024. You'll pocket the most money, allow for huge margins of safety and have plenty of time for things to get back to normal.

Get more trading strategies and investing insights from the contributors on Real Money.

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